Short European banks, says JPMorgan

JPMorgan Cazenove advised investors to short European banks on Monday, as it downgraded the sector to ‘underweight’ from ‘neutral’.

It noted that banks have been one of the best performers in the past six months, second only to energy, and are ahead "nicely" year-to-date, up 8% versus the Stoxx 600 at 1%, to be cumulatively ahead by 60% since September 2020.

"If bond yields are in the process of peaking this quarter, as we suspect, then banks could start to struggle," JPM said.

"After all, the banks rally was underpinned by the sharp move up in bond yields over the past three years, with German 10 year moving from -0.5% to 3%, and US 10-year from 1% to 5%."

JPM said that any potential fall in yields, or a rate cut by the European Central bank next year, will reduce banks’ profitability.

"Further, banks’ deposit base is likely to fall, and with rising deposit betas their net interest income is likely peaking now."

From a regulatory point of view, JPMorgan said the sector might not enjoy as favourable a backdrop as it did recently, with buybacks and capital return to shareholders as good as they get.

"Finally, banks remain much more levered than any other sector, and are a beta play on the overall activity,” it said. “Banks could suffer if economies enter contraction, and if some of the very benign credit backdrop changes next year, with spreads widening and delinquencies rising."

JPM said it was using the funds to upgrade healthcare to ‘overweight’ from ‘neutral’. It said the sector has lagged this year, but could benefit from high US dollar exposure, low beta and "the long duration angle".